Above Par

We all know how this one feels on the course, but that's not what we're going for here. When you buy a bond, it has a face value: that's the set price of the bond when it was issued. That bond will pay interest each year. Bonds trade like stocks, more or less and sometimes, the actual trading value of the bond goes up because investors are willing to pay more than the face value or par value of the bond. Why would they do that? Well, if overall interest rates have dropped, then bonds with coupon rates paying higher interest levels will be bid up. When this happens, your bond can be bid up to be selling above par.

Example: Galactic Empire incorporates and decides to issue bonds because they're in debt after building a new space station. Darth Vader decides he wants to buy a $1,000 bond. He's getting up there in years and wants to be able to enjoy his days in retirement at some point. He gets himself a 5-year bond with a 10% coupon. That means that, every year, he'll get $100 for handing over his cash, and at the end of five years, he’ll get his original $1,000 back. After two years, Darth is dreaming about what he'll do with that money if there's a disturbance in the Force. Interest rates drop. Now the same type of bond from the Empire comes with a 6% coupon because of the change. Good ol' Darth is feeling pretty smug because his bond 10% interest or $100 a year is locked in, but what happens to anyone who wants to invest now?